Activity Based Costing And Agricultural Businesses
Similar to a food chain, all the consumers directly and indirectly depend on the producer. It maybe overlooked by the public but agricultural business are the starting point of all business and progress. These businesses are our producers. For that same reason that the government should aid in the development of agricultural businesses. One way to make moves on developing these kinds of businesses is to look at their management. Management not in the sense of who owns or who handles the business but it pertains to the system which businesses use.
Owners and handlers can be replaced or can be found lacking over time but a system for work flow of the business can be analyzed and improved for future use. This particular case, the John and Mary Farmer case study, simulates this need for a better system in an agricultural business so that it can be more productive and it can stay that way through generations. Improving the Farmer’s business and many agricultural businesses like it can be done using ABC or activity based costing. Activity Based Costing: What is it?
Reading through the details of the case study, the suggested solution for the Farmer’s problem is to make use of activity based costing also called ABC. The definition below is found from the article, Activty Based Costing method ABC approach: ABC is a costing model that identifies the cost pools, or activity centers, in an organization and assigns costs to products and services (cost drivers) based on the number of events or transactions involved in the process of providing a product or service.
Basically, ABC creates a system where the out flow of cash and other resources are allocated according to the activity or activities of the business which utilizes them. Activity centers or cost pools are some terms used to refer to resource consuming processes of the business. These centers come from transactions or events in the flow of the business where resources are involved. Activity centers are determined by cost drivers which are, from the name itself, things which driver or cause a cost. Behind every cost consuming activity of a business is or are cost drivers.
For one activity center there may be more than one cost driver but it greatly helps to determine what these drivers are. ABC is advantageous, for one, because all forms of resources and finances consumed by the activities of the business are accounted for. The standing of the business is not only determined by the amount of money used and gained but also on the number of other resources consumed and gained. Agricultural business like the one of the Farmers involves many steps in preparing the crops for sale and actual selling of the crops.
These steps do not always involve cash payments. As a result, the costs of the activities of the business will be more accurate, compared to traditional costing methods, since ABC takes into account all modes of payment. One difficulty found in using ABC is in the determination of activity centers. Majority of businesses have major costly activities and menial tasks that also cost the business. If a business has too many activities and the importance of these activities varies, it will be difficult to allocate the cost and to continuously update the data.
Collecting data will become more burdensome to the business if ABC is used than traditional costing methods. The activity based costing can make up for the downsides because it allows the management to better see how the business can be improved. All the resources consumed by each activity are shown using ABC so the management can be able to determine how to minimize the costs or at least control the costs. In addition, once cost drivers are determined, minimizing costs would be possible by manipulating the cost drivers.
For large businesses, where there are numerous activity centers and a number of cost drivers, identifying which driver causes which cost maybe difficult. This is because some cost drivers maybe involved in causing the need for more than one cost and activity center. The increasing number of cost drivers and activity centers may also increase the errors in presenting and recording data. ABC in Agricultural Businesses Theoretical knowledge of activity based costing can be applied to the case of the Farmers and other agricultural businesses like it.
Although the business has been in the Farmer family for generations, the same problems have remained in the business for generations as well. With the introduction of a new management system, such as activity based costing, there is a chance that the problems being encountered can be solved. First of all, the Farmers have been using their own management system on the business for a long time. John’s first worry is that the current system is insufficient for the business since he believes it can still be improved. He wants to bring some changes into the system for the time when his son takes over the business.
There are many processes involved in agricultural business which makes use of different resources and equipment. As mentioned above, ABC allocates a business’ costs into separate activity centers. These activity centers are resource consuming transactions of the business. An advantage given by ABC is that the cost is accounted for in all types of payment and consumption. If this was not the case and traditional method was used in accounting for costs, it is highly possible that the cost will be understated or overstated.
Using ABC also answers two more of John Farmer’s dilemmas. Since ABC focuses on the activities of a business, it can be used to differentiate the costs of producing soy from corn crops. As shown in figure 1, the activities concerning soy and corn of individual farms are separated. John can therefore determine the separate costs of the two crops and the costs and yield of each farm. Although the figure has a set back, the salability and the profits of the crops from individual farms are not shown in the final stage in the diagram.
Even if the crops come from farms side by side, there will be some differences when they come out as crops. These differences may influence the consumer on which crop he or she would by. All the crops are bunched together and then sold; however, this could be fixed. The crops can be sold in batches when it reaches the market. Separating the crops when selling them would be quite taxing but it would help determine the efficiency of each farm in producing quality crops. There were two basic designs of the proposed solution diagrams.
Both of these solutions make use of activity based costing but different styles of identifying and allocating the costs to the activity centers. The first method shows a detailed and sequential allocation of costs (refer to Figure 1. Central Schema). The many arrows and boxes may seem confusing but every activity center is individually connected to each other depending on the owner or tenant who is acquiring the cost. The graph also shows a sequential flow of cost allocation.
The cost flows starting from the preparation of materials needed, the processes in preparing the end product, up to the end which is the selling of the end product. In other words, it is a step by step allocation based on the chronological order of activities. The second suggestion shows a simpler looking diagram (refer to figure 2. ). The activities are clumped together in larger or more generalized categories. The case study already mentioned that the alternative solution may not fit perfectly with the wants of John Farmer but the centers are too generalized.
This maybe applicable to large scale operations where being very detailed would be more costly than saving. Since the Farmer’s troubles are not isolated problems, other agricultural businesses maybe facing the same problems as them. Although for the case of the Farmers, using ABC in their business would be a good choice it would not be the same for all businesses. Management systems are like shoes which fit only one size of feet. Careful analysis of the circumstances determines the kind of system that should be employed.
